Rupee Depreciation: Is it a cause of concern?

Rupee depreciation and its impact on the economy, market and people have been in a lot of debate lately.

Last year, the exchange rate of Indian rupee to US Dollar made an all-time of Rs 74.34 on October 9, 2018. Although the currency has recovered a little since making its high and currently hovering at Rs 70.52 (as of January 9, 2019), however, people are still wondering how rupee depreciation can impact their lives.

In this post, we will understand what exactly is rupee depreciation and also analyze the impact of rupee depreciation on different industries, imports, exports, and the stock markets.

How the Rupee value is determined?

In simple words, the rupee value is determined by the forces of supply and demand in the currency market.

If the demand for Indian currency is high, Indian rupee will appreciate. This is called rupee appreciation. For example, if $1 = Rs 70 previously and later it moves to 1$ = Rs 67, then the rupee is said to be appreciating. This also means that our currency is gaining strength against the dollar.

On the other hand, if the demand is low, the currency value will depreciate. For example, if $1 =Rs 70 previously and later it moves to $1 = Rs 73, then it means that the rupee is depreciating. Here, our currency is losing strength against the dollar.

open account with zerodha

Quick Note: Although it’s easier to say that the price of a currency is determined by the forces of supply and demand, what actually drives an increase in demand or supply is a little complex and depends on multiple factors.

Some of the key determinants are inflation in the country, growth rate, interest rates, imports and exports, General macroeconomic conditions of the country, Economic Policies of a government (Fiscal Policy, Budget, Investment policy, and Foreign Trade Policies), political stability, banking capital, commodity prices etc.

Floating vs Fixed Vs Managed Rate System:

Another important concept to understand while studying the currency of a country is its rate system. It can be either fixed, floating or managed float regime.

The floating rate system is a situation in which the value of the currency is freely determined by the market through supply and demand forces and it generally fluctuates constantly.

On the other hand, if the government or RBI exercise controls and fix the exchange rate of a currency (and disallow any fluctuations according to demand and supply forces in the market), such a system is called the Fixed Rate system. It is also called the Bretton Woods system or Pegged Currency System.

However, since this mechanism does not depict the real currency strength (or weakness), most of the countries including India changed to Managed Floating Rate System where currency value is determined by competitive market forces, with intervention by the Central Govt by purchasing rupee in exchange for the foreign currency to increase money supply in the economy which leads to home currency depreciation. Vice versa, it buys foreign currency in exchange for the rupee to reduce the money supply in the economy leading to home currency appreciation.

History of Indian Rupee: A comparison of Indian Rupee Value vs US dollar 

Since October 2008, the exchange rate of INR per USD has depreciated from Rs 48.88 to Rs 70.52 – as of 9th January 2019. Here is a historical data of the exchange rate of Indian rupee per US Dollar.

Year Exchange rate
(INR per USD)
1947 3.30
1949 4.76
1966 7.50
1975 8.39
1980 7.86
1985 12.38
1990 17.01
1995 32.427
2000 43.50
2005 (Jan) 43.47
2007 (Jan) 39.42
2008 (October) 48.88
2010 (22 January) 46.21
2012 (22 June) 57.15
2014 (12 Sep) 60.95
2016(20 Jan) 68.01
2017 (28 Mar) 65.04
2018 (9 May) 64.80
2018 (Oct) 74.00

Source: Wikipedia

Exchange rate inr per dollar

(Source: Tradingeconomics.com)

What TRIGGERS the increase in demand of currency?

Rupee’s appreciation or depreciation against the dollar depends on the dynamics of demand and supply for the currencies. Besides global factors, the following factors also are instrumental in creating the demand:

  • Interest Rate: The interest rate of a country influences the demand for the currency. India with an interest rate of 6-7% would attract greater capital inflow as investors get a higher return than their earnings in the US. (with Interest rates of 2-3%). This results in rupee appreciation.
  • Inflation Rate: A country with lower inflation would have increased demand for its products by foreign buyers. Higher demand for goods & services would translate into higher demand for that currency resulting in currency appreciation.
  • Export-Import: A country exporting more than importing from other countries, would result in higher demand for that currency, causing currency appreciation.

Current Scenario of Currency in India

The Rupee is currently sharply depreciating against the dollar having breached the Rs 70 per dollar mark by the end of 2018. As per a report dated 8 Jan 2019 by Livemint –Analysts say fundamentals will aid the rupee this year.

  “Attractive real yields (net of inflation), growth momentum and robust FX reserves of $394 billion and dollar stabilization are likely to be positive for the rupee, while lower global growth and trade will eventually impact the US economy and asset markets, causing the US Federal Reserve to slow the pace of rate hikes”, -Standard Chartered Bank. (Source: Livemint)

The dollar is expected to stabilize as interest rate differentials between the US and the rest of the world peak.

how the rupee fared last year-min

(Source: Bloomberg)

What are the different impacts?

Industry impact:

Rupee Appreciation means imports turn cheaper and exports become expensive. So, it means good news for companies who are dependent on imported inputs like Petro Products and Engineering Goods as their outflows would decline.

Rupee depreciation means exports earn more. Indian IT sector is dependent on US export revenues.  The contracts with US clients are usually quoted in dollars term. Hence their inflows would increase.

rupee appreciation and depreciation impact-min

Source: Moneyworks4me.com

Stock Market impact:

Foreign investors (FIIs) stand to benefit from a rupee appreciation. Subsequently increased FII inflows could fuel a bull run in the stock market.

To explain with an example: Suppose an FII Invests Rs. 1lakh in the Indian stock market and at an exchange rate of $1 = Rs. 50. So, the amount invested is (1,00,000/50) $2000. Suppose, after 1 year, hypothetical, even if the value of the investment doesn’t appreciate or depreciate, the foreign investor will be in a position to book a profit if the exchange rate has appreciated to $1 = Rs. 40

If the investor sells his investment at the prevailing currency conversion rate, he would get (1,00,000/40)  $ 2500. So, he would book profits of $ 500 due to the rupee appreciation.

Also read: How Does The Stock Market Affect The Economy?

Fuel Shock:

In the case of a Rupee depreciation, the biggest blow to the Indian economy would be the higher outflows due to fuel becoming expensive. India imports most of its fuel requirements from the OPEC countries. This increased fuel costs would result in food inflation as transportation costs become higher. In a developing country like India, this would have disastrous consequences on the vast population.

Summary

In this post, we studied the broad framework of how the exchange rate is decided by the currency market and the factors that influence the Rupee appreciation or depreciation. We also discussed the outlook as per analyst expectations and the impact of the exchange rate fluctuation on the real economy and the stock market.

Although the impact of rupee appreciation or depreciation on individuals and industry depends on which side of the fence they are. However, broadly speaking, rupee appreciation against US dollar is an indicator of a strong, robust Indian economy.

Comments

Leave a Reply

Your email address will not be published. Required fields are marked *